Income Tax: Basis Period Reform in the agriculture sector

Income Tax: Basis Period Reform in the agriculture sector

From April 2024, the way in which partnerships and self-employed individuals are taxed under self-assessment is changing. It will affect those who currently have an accounting year-end that doesn’t align with the tax year of 5 April or 31 March. Farming businesses are likely to be affected by these new rules.

What are the current rules?

Under the current rules, partnerships or sole traders can choose whatever date they wish to draw up their annual accounts. That accounting year-end date determines in which tax year those profits are assessed for tax. For example, an accounting year ended 30 June 2022 will be taxed in the tax year ended 5 April 2023, since it falls within that tax year. An accounting year-end of 31 March 2023 is aligned with the tax year-end, and so is also taxed in the tax year ended 5 April 2023.

For example, when a partner joins a partnership, they are brought into the current tax system under the opening year rules. During these early years the partner will be taxed on profits twice. For example, if a practice has a 30 September year end, this is six months behind the tax year end. Therefore, the incoming partner will be taxed on six months of profits twice. These twice taxed profits are known as overlap profits.

Over their lifetime in the partnership, an individual will only ever pay tax on profits once, since those overlap profits are relieved (deducted from profits) when the accounting year is moved closer to the tax year end or they retire from the business.

Partners will all have different overlap profits as they are determined based on their profit share in their opening years.

What is changing?

From April 2024 everyone will pay tax on 12 months of profits to the end of the tax year – to 31 March/5 April.

This means that all those with non 31 March/5 April year-ends will relieve their overlap profits in the transitional year, 2023/24.

It doesn’t mean that businesses have to change their accounting year-end date. However, if they continue to keep, for example, a 30 June year-end, then their tax return will take three months of profit from one set of accounts and nine months from the next set of accounts, so that they are assessed on a tax year basis. 

What does this mean for my tax bill?

Overlap profits were created when an individual joined the practice or when self-assessment was introduced in 1995/96. Overlap profits aren’t uplifted for inflation so they’re unlikely to represent current profit levels i.e. six months of profits when you joined the partnership may be less than your current six months of profits especially if you joined a partnership on a first share/profit share arrangement which was lower than your current first share/profit share arrangement.   

Accordingly, when you move to this new tax basis, you’ll have an advancement of tax that otherwise wouldn’t hit you until you left the practice or retired.

HMRC do recognise that, when these new rules are implemented, you could pay significantly more tax. Therefore, you’ll be able to spread the excess profit over your current year profits, over five years to help cash flow.

The five year spreading of additional profits is only available in 2023/24.

However, there will certainly be some other problem areas to consider.

1. If you’re not going to align your accounts year to the tax year, accounts may need to be completed earlier to enable tax returns to be submitted. Or estimated figures may need to be used and subsequently revised.

2. Calculating estimated profits will be challenging. Farming profits are heavily impacted by stock and fixed asset changes. There’re going to be a lot of ‘unknowns’ which will make estimating profits hard to get right. It’s likely that revised tax returns will need to be filed.

3. Due to advancement of profits, you might have less time to consider partnership shares which will make tax planning for a typical partnership harder than before.

4. The five-year spreading could affect your tax rate band for the following five years i.e. loss of personal allowance, putting you into a higher tax band. This will have a significant impact on farmer’s averaging calculations as they could become more complex and possibly not as beneficial.

5. If you’re making pension contributions to extend your basic rate band, these may need some more thought in conjunction with proportioned business profits in order to have the desired effect.

6. Cash flow could be an issue if businesses have to pay extra tax from a result of advancement of tax in the transitional year.

Need help?

If you have any concerns regarding the information discussed in this article, or have any other questions, please get in touch with your usual Larking Gowen contact or look for contact details in the Our People section of the our website. Alternatively, call 0330 024 0888 or email enquiry@larking-gowen.co.uk.

Ian Webster